Market Update: Oil & Gas - February 2017

Market Update: Oil & Gas - February 2017

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Looking for clarity

Brent prices seem to have reached critical price levels. Latest price action does not show a clear picture about what happens next. Over the last 2 months prices moved more or less sideways, around the $55 USD per barrel price level, and lost the upward momentum it had in November 2016. The $55 mark currently acts as a strong resistance. A monthly close above $60 would open the door for further price upside. However, the short-term price action looks more like a triple top which could lead to a price correction back to $46-48, the level where the actual medium-term uptrend comes in to play. A monthly close below $44 would indicate further price pressure back to $30-35.

Round 1.4 Reiterates Mexico’s Appeal

Despite a complex global economic context, the Energy Reform is moving forward with Supermajors, Mexican and international companies rallying around its’ first ever private bids for deep and ultra-deepwaters. With an 80% success allocation rate of the 10 contractual blocks, plus the partnership with Pemex to develop the TRION farm-out (1,250 km2); it comes as no surprise that December 5th 2016, was a historic day for Mexico.

According to the Mexican Ministry of Energy (SENER) and the National Commission of Hydrocarbons (CNH), these awards could trigger investments in excess of USD $41 billion over the life-term of the contracts, including the partnership in Trion between Pemex and Australian company BHP Billiton. Authorities stated that in 10 years the eight contracts awarded on top of the Trion investment are expected to generate around 900,000 mbpd, which is equivalent to 43% of current production. However, should the rate of production continue to decline annually at current rates (3.8%), we would lose approximately 38% of production in the next decade, generating a net real growth rate of 5%, excluding benefits offered by other exploration and extraction projects. Hence, the 12.5% growth expected from the development of work resulting from rounds 1.1, 1.2 and 1.3—at peak production—according to SENER estimates. This is 17.5% more than the current net rate. Furthermore, these investments will generate over 400,000 new jobs.

Border adjustable tax unlikely to pass in current form

A proposal included in a Republican tax reform blueprint called "Border Adjustability" – which would make foreign inputs taxable while allowing tax-free production for export markets – is not likely to advance in its current form. The proposal would be a radical alteration of the US tax code, hurting industries that import extensively, like auto production, oil and gas, and retail. The resulting dollar appreciation would also be disruptive for emerging economies with dollar-denominated debt, and would devalue the overseas holding of US companies in dollar terms. Border Adjustability conforms to Trump’s America First program, but his White House has been only sporadically supportive, while Republican leaders in Congress remain divided over the issue. Because the proposal would raise prices for consumers and hurt politically influential industries, it is unlikely to pass in its current form, but Border Adjustability represents a low probability, high risk event for firms.

If Border Adjustability were adopted, it would drive up the cost of US crude imports for refiners. Moreover, US refiners would have an incentive to export more, likely raising gasoline prices in the US.

Dollar appreciation would have broad implications in world energy markets, since nearly all oil sales are denominated in dollars. Faced with less purchasing power, consumption would drop in important Asian markets, but higher prices and a stronger dollar would be a boon for producers after a number of difficult years. Overall, the supply and demand impacts would have mildly bearish implications for international crude prices.

Potential Jeopardy for Asian Refineries?

With the low price environment of the past two years, ASEAN energy demand has continued to surge; accelerating the growth seen in the past decade. Much of this demand growth has been comprised of products in the middle distillate segment, with gasoil and jet fuel/kerosene competing for the lead as the major refined product streams. The imbalance, which has largely been on the demand side, has also seen the expansion into both traditional (coal and natural gas) and newer energy (renewables, biomass, biofuels) sources.

"With OPEC looking to provide a floor to oil prices, many of the efficiency and innovation gains achieved by producers during tougher times are now being leveraged to provide more breathing room. Asian refiners – a group heavily skewed by the Chinese teapot refineries – now face a decline in the refinery margins. The middle distillate surplus within the region has been building; a situation which will see the stress of the past two years flow from the upstream space into the mid-stream. This year will see the condition worsen by planned new and expanded Asian-based (China, Vietnam and Indian) refining capacity increases in the order of 500 to 750 thousand barrels a day."

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.